Europe's Emissions Trading Scheme unites the 25 states of the European Union in an attempt to cut emissions of the gases fuelling climate change.
Energy-intensive plants have trading carbon since 2005
What is carbon trading?
Since the beginning of 2005, about 12,000 energy-intensive plants in the EU have been able to buy and sell permits that allow them to emit carbon dioxide (CO2) into the atmosphere.
Companies that exceed their individual limit are able to buy unused permits from firms that have taken steps to cut their emissions.
Those who exceed their limit and are unable to buy spare permits are fined 40 euros (£27) for every excess tonne of CO2.
Industries included in the Emissions Trading Scheme (ETS) include power generation, iron and steel, glass and cement. Overall, the ETS covers about 40% of the EU's total CO2 emissions.
Why is it needed?
Under the UN Kyoto Protocol, a legally binding global agreement to reduce greenhouse gas emissions, industrialised nations are obliged to reduce the amount of greenhouse gases being released into the atmosphere.
The EU is required to cut its emissions by 8% from 1990 levels by 2012. The ETS is Europe's main mechanism to achieve this.
It works by each nation agreeing a National Allocation Plan (NAP) with the European Commission. The NAPs allocate individual limits for the plants covered by the scheme.
By setting the total number of permits below the current level of emissions, the ETS should lead to a reduction in the amount of CO2 being emitted.
Has it been successful?
The idea behind Europe's trading scheme has been hailed as a positive step in the effort to tackle human-induced climate change.
Organisations such as the UN and the World Bank have praised the ETS, and say it can form the basis of a global system.
However, in practice, the ETS has had a rough ride. Nations have issued more permits to pollute than required in the first phase, which runs until the end of 2007.
This has resulted in carbon prices falling as low as eight euros (£5) per tonne. This means that it has been cheaper for firms to buy spare permits than pay the 40-euro fine, or take steps to reduce their emissions.
Talks are currently underway for NAPs covering the second phase, but a number of nations, including Germany, have expressed concern that the European Commission is setting limits too low.
However, Environment Commissioner Stavros Dimas has said the EU had to show leadership if it was to convince other nations, especially Australia and the US, that carbon trading schemes worked.
Why is aviation now being included in the ETS?
EU emissions from the international air transport sector are increasing faster than any other sector, says the European Commission.
Emissions from EU commercial flights are set to subject to limits
Although aviation only accounts for 3% of the EU's greenhouse gas emissions, the sector has seen an 87% increase in CO2 since 1990 following the emergence of cheap air travel.
According to the Commission, someone taking a return flight from London to New York will generate about the same amount of CO2 as an average person heating their home for a year.
Under the proposals, the ETS will cover commercial flights within the EU from 2011, and all flights to and from the EU in 2012. Domestic flights (eg. London to Manchester) are already subject to national limits set by the Kyoto Protocol.
Airlines favour carbon trading rather than taxes on fuel or emission charges.
The Commission says it expects any increase in ticket costs to be limited, and much lower than rises resulting from soaring oil prices in recent years.
What happens next?
The European Commission is currently negotiating with national governments over the limits to be set in the second phase of the ETS, which runs from 2008-2012, with the final NAPs to be in place by the summer of 2007.
In January, the Commission is expected to announce a new target to cut to carbon emissions. It is set to call for a 30% reduction from 1990 levels by 2020, and the ETS will play a key role in delivering this target.
Internationally, Australia's Prime Minister John Howard has set up a task force to look at carbon trading.
Australia along with the US refused to sign the 1997 Kyoto protocol, fearing it would damage their economies while not requiring developing countries such as China and India to reduce emissions.
Such a move could pave the way for an international carbon trading scheme to form the central pillar of a post-2012 Kyoto agreement.